Is Dollar Cost Averaging Worth It?

For Warren Buffett, David Einhorn, Ray Dalio, and Larry Fink, stock picking makes sense. Each of them has built fortunes by betting on the right stocks, building funds, and successful institutions that oversee trillions of dollars collectively.

For the ordinary trader, it’s easy to get swept up in the hype of fast-growth stocks and big moves that make headlines on news networks. The reality is it’s important to stick with a process to consistently outperform. That’s the reason why Buffett spends all day every day reading.

So, how can the ordinary person beat average returns?

What Most Investors Don’t Know

The hidden truth behind investing is not so much that it’s hard to find a way to outperform the market but that doing so requires consistent effort.

When you look to Buffett, it’s easy to think with his billions of dollars that beating the market is hard. The way the Oracle of Omaha invests does indeed require a lot of leg work. He examines balance sheets to make sure cash levels relative to debt are sustainable. Income statements are scrutinized to verify profitability. Cash flows are examined to confirm levered free cash flows are consistently in the black.

And then there are the financial multiples. Warren wants to know the price-to-earnings ratio is low relative to historical norms so the margin of safety is attractive.

Another less well-known metric he seems to pay close attention to is shareholder yield that includes not only the dividend yield, an important factor on his radar, but also the net effect of buybacks.

Most importantly, Buffett wants to know that a company has a sustainable competitive advantage that is exemplified by a wide moat in the form of a high return on invested capital.

Over the past half century and then some, Buffett’s formula beat the market by an average of 2x per year, meaning where the market averaged 10% annually, Berkshire Hathaway averaged closer to 20% per year.

Those ingredients are just a few he puts into the mix and it’s easy to see why the combination may seem intimidating to new investors. But there are other approaches that lead to success.

US Champion trader, Oliver Kell, follows a completely different approach which is heavily based in technical analysis. He looks for stocks breaking out and rides their waves of momentum to higher prices, albeit with a strict ruleset. His trading style produced a 941.1% return in 2020.

And then there is Stanley Druckenmiller, who likes to find fundamentally solid stocks that have good-looking charts too. Druckenmiller’s approach resulted in a track record of 30% annually, on average, for approximately three decades. 

The takeaway from these three track records and different styles is that there are many ways to beat the market. And yet most investors don’t. It’s been reported that as many as 9 out of 10 active investors underperform the market averages over the long haul.

Why Do Active Traders Underperform?

While the approaches of Buffett, Kell, and Druckenmiller are all different, what they have in common is a discipline to stick with their respective investing styles. That is so much easier said than done. 

For example, imagine being Buffett when Cathie Wood’s ARK Invest growth fund was wiping the floor versus Berkshire Hathaway in 2020 and 2021 and media headlines questioned whether Buffett had lost his touch?

On a more personal note, imagine that you decide Buffett’s approach is best for you but then every financial media outlet you turn to seems to be pitching the merits of bitcoin, which incidentally Buffett despises. It’s very tempting to start trading crypto when so much easy money was being made for so long.

Sticking with a single approach is hard. It requires discipline, no matter what the outside world is reflecting back to you. And it requires consistent study.

If that doesn’t appeal to you then making regular investing contributions has a lot of merit. 

Is Dollar Cost Averaging Worth It?

Dollar cost averaging is a good idea for passive investors and active investors who struggle to stick with a single investing method.

By regularly committing to invest a fixed dollar amount monthly, an investor guarantees they will never buy the top of the market, but equally they are assured to never buy the bottom.

For some investors, the hardest part of dollar cost averaging is to stick with the process when the market falls. It can be emotionally challenging to continue to invest when each month the market is going lower but that’s precisely when cost basis reduces and the long-term merits of the approach pay off.

If you are not convinced, just keep in mind that even Warren Buffett has advocated for his heirs to choose the S&P 500 over and above his own Berkshire Hathaway.

The reasons for this are numerous. For one, it’s possible that even a great company like Berkshire is one day led by a poor leader who makes worse investment decisions. The odds of five hundred poor CEOs taking over the top 500 firms in the US are orders of magnitude lower.

Similarly, a Berkshire CEO needs to be able to have the emotional strength Buffett has displayed to be ready to pounce on undervalued stocks during the worst financial conditions. Whether his successor can will remain a point of contention until a recession, or worse, comes along.

The other aspect of the S&P 500 is that it is much more balanced than most investment portfolios. When oil prices are rising, for example, energy stocks may be doing well while other companies that suffer from high energy prices pull back.

The index is a composite so no single variable, such as oil prices, will necessarily affect all stocks equally, absent a major catastrophe or black swan event. The same is not always true of investment portfolios run by active managers, which inherently means more risk.

The bottom line is investing in the S&P 500 over time offers a lot of pluses versus selecting a single stock, even if that position is Berkshire Hathaway with its own diversified investments under its corporate umbrella.

---

The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.